The Housing Crisis is Over

Here's a brave call from Cyril Moulle-Berteaux, a managing partner at New York-based hedge fund Traxis Partners. Writing in the WSJ, Berteaux suggests that housing prices are starting to bottom and that the crisis is largely behind us. Why? Because the pace of house sales is approaching an historical trough and inventories will quickly shrink as homes become more affordable:

Home sales peaked in July 2005. New home sales are down a staggering 63% from peak levels of 1.4 million... During the 1990s and early 2000s, it took 19% of average monthly income to service a conforming mortgage on the average home purchased. By 2005 and 2006, it was absorbing 25% of monthly income... That just proved to be too much.

Since then, house prices have fallen 10%-15%, while incomes have kept growing (albeit more slowly recently) and mortgage rates have come down 70 basis points from their highs. As a result, it now takes 19% of monthly income for the average home buyer, and 31% of monthly income for the first-time home buyer, to purchase a house. In other words, homes on average are back to being as affordable as during the best of times in the 1990s. Numerous households that had been priced out of the market can now afford to get in.

As the price of servicing a mortgage falls to a certain level of income, inventories begin to shrink as prospective homeowners snatch up homes at more affordable rates. As this happens, prices gradually bottoms and recovers. Housing slumps always follow this pattern, argues Berteaux, and we are very close to the bottom of the cycle:

In the past five major housing market corrections (and there were some big ones, such as in the early 1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home sales bottomed, the pace of house-price declines halved within one or two months.

The explanation is that by the time home sales stop declining, inventories of unsold homes have usually already started falling in absolute terms and begin to peak out in "months of supply" terms. That's the case right now: New home inventories peaked at 598,000 homes in July 2006, and stand at 482,000 homes as of the end of March. This inventory is equivalent to 11 months of supply, a 25-year high – but it is similar to 1974, 1982 and 1991 levels, which saw a subsequent slowing in home-price declines within the next six months.

But what about the doomsayers who say that prices still need to fall an additional 30%? Nonsense, says Berteaux. Their analysis is incomplete because they aren't factoring in the effect of interest rates on relative affordability across different time periods:

...If one buys a house with a mortgage, the most important factor in deciding what to pay for the house is how much of one's income is required to be able to make the mortgage payments on the house. Today the rate on a 30-year, fixed-rate mortgage is 5.7%. Back in 1981, the rate hit 18.5%. Comparing today's house prices to the 1970s or 1980s, when mortgage rates were stratospheric, is misguided and misleading.

So houses are as affordable now as they were then, even if prices relative to rents or incomes are higher.

What Mr. Berteaux hasn't factored into his analysis, is the inflated price of energy and consumer goods. The average household now spends considerably more, in real terms, buying things like gasoline and milk, which leaves less room in the budget for servicing a mortgage. Whether this offsets the benefit of cheaper mortgages is arguable. Either way, just because prices are bottoming doesn't mean we're out of the woods:

We are of course experiencing a serious housing bust, with serious economic consequences that are still unfolding. The odds are that the reverberations will lead to subtrend growth for a couple of years. Nonetheless, housing led us into this credit crisis and this recession. It is likely to lead us out. And that process is underway, right now.